There’s something we’re seeing more and more of here at ESS Settlement Services. It’s subtle, quiet and often sneaks in at the last minute, when all but the sharpest sets of eyes are no longer paying attention. It’s something we think more lawyers should know more about and be wary of: one-sided confidentiality clauses.
It’s no secret that a large percentage of settlements have a confidentiality clause thrown in at some point. This is to ensure that both parties keep the contents of the document private and it’s often important to many clients. The problem arises when only one side is subject to confidentiality and that problem is taxes.
Take the now famous Amos case, for instance, where prominent Chicago Bulls basketball player Dennis Rodman chased a ball out of bounds and fell onto a group of photographers. As Rodman, who was known for erratic behavior, disentangled himself from the throng he kicked photographer Eugene Amos in the groin.
Amos alleged that the kick was intentional and lawyered up, seeking damages for his injuries. Rodman’s attorney contacted him shortly after and the parties agreed to a $200,000 settlement, before a lawsuit was filed. The settlement imposed an obligation on Amos to keep the terms confidential.
Settlements for physical injuries or illnesses are ordinarily tax free, so Amos excluded the full $200,000 from his taxes. However, the IRS audited him and declared that only a nominal amount was tax-free because his injuries were minor and the bulk of the amount was simply to keep the settlement confidential and prevent Amos from defaming or disparaging Rodman. Ultimately, the court ruled that 60 percent was exempt, while 40 percent of the settlement was taxable.
Though the Amos case is unique, it clearly illustrates the dangers of one-sided confidentiality clauses in personal injury cases. In standard settlement agreements, confidentiality is mutual because one party exchanges their silence for the other party’s, not for monetary compensation. In other words, mutual confidentiality dampens the taxable amount because the Supreme Court has ruled that typical personal injury settlements are tax-exempt.
We see cases with this issue all the time and we’d like for lawyers to watch out for one-sided confidentiality clauses and not let them get thrown in at the last minute. In addition to non-mutual confidentiality, lawyers should be concerned about agreements that explicitly state that a portion of the money is just for confidentiality, settlements that require the plaintiff pay liquidated damages for breaching the confidentiality, or if the plaintiff agrees not to assist with criminal prosecution.
While all of these concerns were present in the Amos case, typical personal injury settlements are far simpler and it’s easy to keep them tax exempt, as long as lawyers are watching out for their clients and don’t let the other party sneak any nefarious clauses in at the eleventh hour.
Are you aware of other examples of confidentially clauses affecting a settlement? Please share your thoughts with us by commenting below